Fund and trust jargon buster: everything you need to know

by Kyle Caldwell from interactive investor |

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Before buying a fund or investment trust get to grips with the lingo. Here’s everything you need to know.

The world of finance is riddled with jargon that acts as a barrier for beginner investors. In this glossary, we break down into plain English the various terms and phrases that investors interested in funds and trusts will encounter when researching what to buy.  

Many of these terms appear in fund and trust factsheets, which is a two or three page document that gives a quick overview of a fund’s performance. It will also explain where the fund is currently investing, the top 10 holdings and how the fund manager invests, as well as other key information.

Asset class: the type of investment the fund invests in, most commonly shares, bonds, property or alternative investments such as infrastructure or gold.

Active management: the managers of actively managed funds attempt to outperform a benchmark, most commonly a comparable stock market, by researching, analysing and actively selecting what the fund manager believes to be the best investments to buy.

Active share: a fund’s ‘active share’ ratio, where available, shows how much its holdings differ from its benchmark. The higher the ratio, the more active the fund manager is likely to be. A fund that holds the same stocks as its benchmark in the same proportions will have an active share of 0%, while a fund that completely differs from the index will have an active share of 100%.

Benchmark: the yardstick against which funds and trusts measure their performance. It is usually an index, such as the FTSE 100 in the case of a UK equity fund. While less common, some funds measure their performance against competitor funds in their fund sector.

Compounding: refers to the way investment returns themselves generate gains. For instance, if you invest £1,000 into a fund that gains 5% over one year, you will earn £50. Assuming that you don’t withdraw any money, the next year you will earn 5% on £1,050, which is £52.50. This does not sound like much of an uplift, but as each year passes, the compounding effect multiplies. The effect becomes even more powerful when dividends are also reinvested and allowed to compound.

Discounts and premiums: investment trusts have a share price that moves according to investor demand. This price does not directly reflect the value of the underlying investments in the trust. The share price of the trust will generally either be higher (at a premium) or lower (at a discount) than the underlying holdings. A discount means investors can buy the trust cheaply, whereas investors who buy at a premium are paying more than the value of the underlying holdings are worth.

Diversification: the strategy of investing in a wide range of investment types, with the aim of reducing overall risk. In a fund or trust factsheet you may see ‘diversified portfolio’ mentioned. A fund with a large number of holdings across different industries and sectors is said to be diversified. Global funds, due to not being constrained to a single region, are diversified by country.

Dividends: a sum of money paid by a company to its shareholders out of profits, either quarterly, or once or twice a year. In a fund or trust factsheet the frequency of how often dividends are paid should be stated.

Dividend reserves: investment trusts are able to retain 15% of income generated each year, which means they can build up a ‘rainy day’ reserve to bolster dividend payouts in years when income is lower.

Dividend yield: a percentage figure that gives an indication of the level of income investors may receive from a fund or trust. Most commonly, an historic 12-month yield is used, which is the calculation of dividend or interest payments made over that period. Bear in mind that the yield is an estimate and, as the 12-month yield is backward-looking, it may not accurately reflect the yield of the fund or trust at present.

Equity ‘style’: fund managers invest in different ways. Some follow the ‘value’ style of investing, which is to invest in shares considered to be a potential bargain. Other fund managers prefer to invest for ‘growth’ by backing businesses they believe have the potential to grow faster than the market. Some growth-focused fund managers focus their sights on small companies that have greater growth potential than large companies, like those you might find in the FTSE 100 index.

Exchange-traded funds (ETFs): a type of passive fund listed and traded on the stock exchange, which tries to track the performance of a particular stock market index, or other asset class like gold or oil. It does not pick individual stocks it thinks will outperform. ETFs that follow the up and down fortunes of developed markets, such as the US or UK, can cost as little as 0.1%, which works out at £10 on a £10,000 investment.

Fund objective: this spells out what the fund or trust is aiming to achieve, such as growth, income or a mixture of the two. The objective usually states a time period, which represents the length of time the fund feels should be used by investors to judge the fund manager’s performance versus the benchmark.

Fund sector: funds are housed in a fund sector along with competitor funds that invest in the same part of the market.

Fund size: the total assets of the fund or trust. Generally speaking, funds with assets of over £1 billion are considered large funds, while those with less than £100 million are considered small. Larger funds are more constrained than smaller funds when it comes to owning smaller company shares. A large fund would need to own a significant portion of a smaller company for it to be a meaningful position in the portfolio. 

Gearing: investment trusts have the ability to gear (borrow to invest). In a rising market this can enhance returns, but in a falling market losses can be steeper. Most trusts that invest in shares tend to stick to a gearing range of 0% to 20%. A high gearing level indicates the investment trust manager is bullish on the outlook for the area they invest in. In contrast,  a reduction in gearing, or a low gearing level, signals the fund manager is taking a more cautious approach at present.

Investment policy: this details the parameters for the fund, such as the minimum amount of exposure it is required to hold in the area it invests in. For example, UK funds must hold at least 80% of their portfolio in UK shares. 

KID: investment trusts are required to produce Key Information Documents, or KIDs, which include important information about a fund, such as how the fund invests, its risk profile and charges. The document attempts to be forward-looking to give investors an idea of what they may pay in the future by including potential transaction costs, gearing costs and performance fees.

KIID: why have one KID when you can have two? The Key Investor Information Document, or KIID, is for funds, rather than trusts. It is similar to the KID, but discloses charges differently. The KIID details how the fund invests, its risk profile and charges. But, in regard to charges, portfolio transaction costs are not included, meaning the true total cost is not stated. Instead the ongoing charges figure (see below) is used.

Liquidity: in the investment world ‘liquid’ describes an investment that can be bought or sold quickly and easily. Investments considered ‘illiquid’ can at times be difficult to sell, due to a lack of buyers or the nature of the investment. Property is considered illiquid, for instance.

Ongoing charges figure (OCF): the annual cost of investing in a fund, expressed as a percentage of the value of your investment. Unfortunately, trading costs (incurred when the fund manager buys or sells investments) are not included in the OCF, so the true annual cost will be higher than the stated OCF. Actively managed funds typically tend to have an OCF of around 0.85%, which works out at £85 on a £10,000 investment.

Open-ended and closed-ended: open-ended is a term used for funds, which are either structured as a Unit Trust or Oeic (see below for explanations on both of those). Funds are collective investments that do not have a fixed size, which is why they are referred to as open-ended. When new investments are made into the fund new shares/units are created.

Investment trusts, however, are described as closed-ended due to having a fixed number of shares, meaning for every buyer there has to be a seller.

Passively managed funds: in contrast to active funds, passive funds (structured as index funds or ETFs) aim to mirror the performance of a market. This is achieved by simply holding the same investments and weightings as the index. So if BP makes up 5% of the FTSE 100 index, a UK passive fund aiming to replicate the FTSE 100 will also invest 5% in BP.

Peer group percentile: the fund factsheet details how the fund has fared versus the sector over certain time periods. Funds in the top quartile of the sector over a given time period are among the top 25% performers. Looking across different time periods to compare performance of the fund versus the sector – one year, three years and five years – will give investors an idea as to whether performance is consistent or not.

Share class: funds have different share classes – four or five in some cases. The income share class is normally designated 'Inc' and accumulation abbreviated to ‘Acc’. The income share class is suited to those who want to draw an income, for instance those using their investments to help fund their retirement. The accumulation share class is better suited for those who do not need an income and are focused on building up their ISA and/or SIPP. Any dividends are reinvested back into the fund. Those who pick the accumulation share class will benefit from the effect of compounding - which means in effect that they get returns on their returns.

There are various letters attached to fund share classes – R, I, C, A – to name a few. The best course of action is simply to buy the cheapest share class on offer at interactive investor and then choose between taking any income produced by the fund, or opting for income to be reinvested.

Tracking error: the efficiency of an index fund or exchange traded fund in tracking the stock market index it is trying to replicate is measured by its tracking error. The lower the percentage figure (the closer to zero error), the better. Conversely, the higher the percentage, the more the tracker has deviated away from the stock market it follows. Costs have the most significant impact on the tracking error, accounting for most of the deviation from the index in question.

The tracking error can also be affected by transaction and rebalancing costs. The tracking error may also be higher for passive funds that do not fully replicate the whole index – it is not uncommon for some to choose not to own the smallest shares in a large index.

Unit Trusts and Oeics (which stands for open-ended investment companies): in practice, there is little difference between the two structures and it does not matter either way which structure the fund adopts as far as investors are concerned. In both cases the shares or units reflect the value of the fund’s underlying investments.

The key difference is the way they’re priced. Unit trusts quote a bid price (if you sell units back to the fund) and a higher offer price (if you buy them). Oeics only quote one price.

Funds with a unit trust structure create units when investors want to buy, and cancel units when investors sell. An open-ended investment company, or Oeic, operates in a similar fashion, but is structured as a company, although not listed on the stock exchange. Instead of units, shares are created and cancelled when investors buy and sell.

Sharpe Ratio: a useful aid for investors hunting for active funds that stand out from the crowd is the Sharpe Ratio. The ratio measures the historical risk-adjusted return. In other words, how much excess return investors have received from the fund or investment trust to compensate for the risks attached. The higher a fund's Sharpe ratio, the better its returns have been relative to the risk it has taken on.

Top-down and bottom-up: in fund management lingo, the words top-down and bottom-up are used by fund managers in everyday conversation to explain how they pick shares when building a portfolio. Those who describe themselves as top-down investors factor in the big picture, examining wider economic trends. In contrast, a bottom-up investor completely ignores the so-called macro, and instead focuses specifically on the fundamentals of a business. In reality, the majority of fund managers pick stocks first and foremost, but bear in mind the wider economic backdrop.

Undertaking for Collective Investments in Transferable Securities (UCITS): you may see the acronym UCITS on a fund factsheet. All you need to know is that it means the fund is allowed to be sold to investors in Europe and the fund has to follow certain rules.  

Underweight/overweight: the term underweight in the fund world is used to get across that a fund manager has a smaller weighting to a share compared to the stock market. For instance, if BP makes up 5% of the FTSE 100 index and the fund manager holds a 3% position, the fund manager is underweight. But if the fund manager held 7% in BP then they would be said to be overweight. The underweight/overweight terms are also used for sectors and countries (for global funds). 

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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